How to recognize revenue when rights of return are present

3. Example of deferring revenue until the right of return expires

Letís continue with our example of company AndroidMow. In June 20X2, the company developed a new product called GreenAndroMow. The company lacks sales experience with the targeted market. Due to the uncertainty, the company cannot estimate the rate of product returns. Thus, the company cannot recognize the revenue on the 100 units sold for $200,000 (i.e., $2,000 sales price per unit) at the time of sale and should wait until the return period expires.

The associated cost of goods sold for the 100 units was $120,000 (i.e., $1,200 cost per unit). The company issued a three-month return policy to its distributors.

In this example the company is not able to reasonably estimate the rate of product returns. Assume, however, that all other criteria for revenue recognition are met.

In June 20X2, the company cannot recognize revenue as the result of the uncertainly regarding the product returns. AndroidMow would make the following journal entries at the time of sale:

Account Titles

Debit

Credit

Accounts Receivable

$200,000

 

      Unearned Revenue

 

$200,000

Account Titles

Debit

Credit

Consigned Inventory

$120,000

 

      Finished Goods Inventory

 

$120,000

Once the product return policy expires at the end of three months (in September 20X2), the company can record the sale and related revenue with the cost of sales:

Account Titles

Debit

Credit

Unearned Revenue

$200,000

 

      Revenue

 

$200,000

Account Titles

Debit

Credit

Cost of Goods Sold

$120,000

 

      Consigned Inventory

 

$120,000

As we can see from this example, the seller can consider goods to be sold if the future amount of product returns can be reasonably estimated (and all other criteria to recognize revenue are met). In such a case, the seller can recognize profit and remove merchandise from its inventory. On the other hand, if product returns cannot be reasonably estimated, the seller will delay revenue recognition until the product return policy expires or the product returns can be estimated.

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